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Slow Learners

August 19, 2016 1:11 pmAugust 19, 2016 1:11 pm

Larry Summers has a very nice essay that takes off from a new paper by John Williams at the San Francisco Fed, which is noteworthy because Williams is the highest-placed Fed official yet to suggest that maybe the inflation target should be higher. It’s not a new argument
– see, for example, my paper for the ECB in 2014, but seeing it come from a senior official is news.

Yet as Larry says, the paper is still weak and tentative even on monetary policy, to an extent that’s hard to understand:

I am disappointed therefore that Williams is so tentative in his recommendations on monetary policy. I do understand the pressures on those in office to adhere to norms of prudence in what they say.
But it has been years since the Fed and the markets have been aligned on the future path of rates or since the Fed’s forecasts of future rates have been even close to right.

Furthermore, there’s basically no break with orthodoxy on fiscal policy, despite the evident importance of the liquidity trap, evidence that multipliers are fairly large, and basically zero real borrowing costs.

Yet Williams is at the cutting edge of policy rethinking at the Fed. And in general mainstream thinking about macroeconomic policy has changed remarkably little, remarkably slowly.

You might say that it is always thus. But, you know, it isn’t.

I fairly often find myself comparing the intellectual response to the financial crisis and its aftermath with the response to the emergence of stagflation in the 1970s. I say the 70s, but really stagflation emerged
as an issue in 1974, after the first oil shock, and pretty much ended with the Volcker double-dip recession of 1979-82 – a recession whose end implication was that monetary policy continued to work in a fairly
Keynesian way. So it was well under a decade of experience; yet it utterly transformed how everyone talked about macroeconomics.

Then came the 2008 crisis. As I’ve written many times, events since that crisis have played out pretty much the way someone who knew their
Hicksian IS-LM would have predicted – but that should have been shocking to the many people, both in policy circles and in the economics profession, who dismissed that kind of economics as worthless, proved
false, whatever. And the sheer persistence both of depressed economies and of low inflation/interest rates should by now have led to a big rethinking. Depression economics redux has now gone on as long as stagflation
did.

Yet rethinking has been glacial at best. People who warned about the coming inflation in 2009 are warning about the coming inflation in 2016. Orthodox fears of budget deficits still dominate a lot of discourse. And
the Fed still clings to an inflation target originally devised in the belief that the kind of thing that has happened to our economy would never happen.

I’m not entirely sure why learning has been so slow this time. Part of it, I suspect, is that the anti-Keynesian backlash of the 1970s had a lot of political power, and behind the scenes a lot of money, behind
it – which influenced even academics, whether they realized it or not. And these days that same power and money is deployed against any rethinking.

Whatever the explanation, however, it’s taking a painfully long time for serious policy discussion to arrive at a point that should have been obvious years ago.